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Personal Financial Skills:Personal Financial Skills:WORKBOOK 4:

Getting a Loan

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Consumer Credit Counseling Serviceempowers people to enjoy a lifetime ofeconomic freedom. CCCS educates allsegments of society in the wise use ofcredit and provides an impartial forum forresolving debt problems. Named Agencyof the Year for 1999 and 2000 by theNational Foundation for CreditCounseling, CCCS Atlanta is the nation'spremier debt-management serviceorganization, characterized by excellence,integrity and technological innovation.

PersonalFinancial Skills

Realizing Your Financial Goals

Whether you want to buy a home, start a business or pay off your

debt, personal financial skills are the first step to taking control of

your financial future. The Personal Financial Skills workbook series

will help you learn the necessary skills to maintain a family spending

plan, use checking and savings accounts, build or repair your credit

history, and apply for a loan. Regardless of your age, occupation or

financial management experience, you will find useful skills and tips

throughout this self-study material. Enjoy!

The Fannie Mae Foundation createsaffordable homeownership and housingopportunities through innovativepartnerships and initiatives that buildhealthy, vibrant communities across theUnited States. The Foundation is speciallycommitted to improving the quality of lifefor the people of its hometown,Washington, DC, and to enhancing thelivability of the city’s neighborhoods.

The Home Depot is the largest retailer inthe home improvement industry. Ourgoal is to provide the highest level ofcustomer service, the broadest selectionof products and the most competitiveprices. We are a values-driven companyand our eight (8) core values include thefollowing: Excellent customer service •Taking care of our people • Giving back •Doing the "right" thing • Creatingshareholder value • Respect for all people/Entrepreneurial spirit • Building strongrelationships.


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Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Workbook objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

Types of financial institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4

The credit system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

Evaluating a loan application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Applying for a loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

Credit denials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Getting to yes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18

Loan rates, terms and fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

Predatory lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28

Summary points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

Knowledge review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

Answer section . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38

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So, you want to take control of your financial future –

You’ve come to the right place. This self-study workbook series will help you todevelop critical skills for financial independence. There are four workbooks:

Workbook 1: Developing a Spending PlanWorkbook 2: Working with Checking and Savings AccountsWorkbook 3: Understanding Credit and Your Credit ReportWorkbook 4: Getting a Loan

Developing personal financial skills is the first step to taking control of your financialfuture. We have written these workbooks to help you learn financial skills that will giveyou the ability to plan your future. The following steps will help you use this workbookas a guide for your independent learning:

1. Begin each chapter by quickly scanning the headings. This will give you a basic idea of what you will be studying.

2. Each chapter has a number of subsections. Each subsection begins with study objectives stated as questions. To complete this workbook you will need to be ableto answer these questions. As you read and find the answers, underline orhighlight them for later reference. It is important to underline and write in this bookto reinforce your learning.

3. All bold terms are defined in the workbook glossary. Refer to the glossary to assist you.

4. A short self-assessment follows each subsection. This will help check and reinforce what you have read. Answer each question and then check your answersat the bottom of the exercise.

5. At the end of each chapter you will find a Knowledge Review. Use this opportunity to review the concepts discussed in this workbook.

6. You will need a pencil and a calculator to complete this workbook.


3

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kGetting a Loan

Workbook Objectives

In this workbook you will learn about: • different types of financial institutions• the lending process• completing a loan application• evaluating loan rates, fees, and terms• ways to avoid predatory lending• the importance of insurance

Have you ever applied for a loan? What do you know about the types of financial institutions thatoffer lending products and services? Do you understand how financial institutions evaluate loanapplications? Do you know how loan rates, terms, and fees will affect the cost of your loan? If youare interested in getting a loan, this workbook will provide you with the information you need tounderstand the lending process.

Your Loan Experience Exercise

Answer the following questions to find out how much you know about applying for a loan.

1. What are the differences between a loan fund and a bank?

2. Have you ever applied for a loan? ___________

3. List three pieces of information that are required to complete a loan application.

4. How does the interest rate affect the cost of credit?

5. How does the size of your down payment affect the cost of credit?

6. How do you know whether a lender has charged you excessive rates or fees?


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Types of Financial Institutions

Financial institutions are businesses that provide services such aschecking accounts, savings accounts, and loans. Banks, savingsand loans, credit unions, finance companies, and loan funds areall types of financial institutions. As you learn to manage yourfinances, your needs will change. Different types of financialinstitutions are available to meet different needs and provide arange of products and services.

Examine the chart on page 5 to learn about the differencesamong financial institutions. In addition to loans, some financialinstitutions offer depository services. This means that you canopen a checking account or savings account at these institutions.Also pay attention to the financial institutions that are eitherFederal Deposit Insurance Corporation (FDIC) or National

Credit Union Share Insurance Fund (NCUSIF) insured. Thegovernment regulates these financial institutions and insures customer deposits for upto $100,000 per account. After you read through the chart, try to identify a localfinancial institution in each category.

Study Objectives

Underline/highlight the

answers to these questions

as you read:

1. What are the different

types of financial

institutions?

2. Which types of financial

institutions offer

depository services?

3. What is FDIC and

NCUSIF insurance?


5

Depository Credit Products/ List Local Mission Products Terms Insured Institutions

Banks/Savings Banks

Credit Unions

Finance Companies

Loan Funds

These for-profit financialinstitutions are the largestsource of deposits and creditin the economy. Businessdecisions are driven by thedesire to make a profit.

These nonprofitcooperative financialinstitutions exist to servetheir members’ financialneeds.

These for-profit businesses makeconsumer and commercial loans. They focus on servingborrowers who areconsidered too risky forbanks, such as individualswith poor credit histories.

Loan funds are pools ofmoney established to makeloans in situations whereconventional sources offinancing do not exist. Asthe loans are repaid, themoney is lent out again.Lending practices in theseorganizations are usuallyguided by a communitydevelopment mission.

Providedepositoryservices toindividuals andorganizations.

Providemembers withdepositoryservices.

None

None

• Deposits are used to make personal, business, and real estate loans.

• Fees and interest rates are set by the market.

• Provide members with credit services. • Specialize in meeting family credit

needs (auto, mortgage, home equity, and emergency loans).

• Consumer finance companies make small installment and home equity loans.

• Business finance companies finance assets (e.g., inventory, equipment).

• Sales finance companies make loans for large items such as refrigerators, cars, and mobile homes.

• Finance companies usually charge higher rates of interest and more fees than other lenders. Terms are often short-term.

• Provide individuals, businesses, nonprofits, and housing organizations with loans (typically specialize in housing or small business loans).

• Prefer lending to organizations that do not have access to capital through mainstream sources.

• Structure, terms, and underwriting of loans are more flexible than main-stream sources of capital.

• Often seek projects that result in job creation.

FDIC*

NCUSIF**

No

No

* The Federal Deposit Insurance Corporation (FDIC) insures accounts at federal government-regulated financial institutions for up to $100,000 per account.

**Nations Credit Union Share Insurance Fund (NCUSIF) insures accounts at federal government-regulated credit unions for up to $100,000 per account.

Financial Institutions Table


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The Credit System

As you learned in Workbook 3: Understanding Credit and YourCredit Report, credit is used to start businesses, build houses,buy houses, and make needed purchases. Before you applyfor a loan, it is useful to learn about the credit system and thecriteria used by financial institutions to make loan decisions.

People gain access to credit from many sources, such as banks, loan funds, credit unions,car dealers, and pawnshops. Working with a traditional lending institution (e.g., a bank, aloan fund, a credit union) provides you more consumer protection than an informal sourceof credit (e.g., a pawnshop, a check-cashing company). The diagram on the followingpage describes how lending institutions work.

SELF-ASSESSMENT 11. True or False. All four types of financial institutions offer depository services.

❏ a. True❏ b. False

2. When your account is FDIC-insured it means that (check all that apply):❏ a. the financial institution is regulated by the government.❏ b. the financial institution is not regulated by anyone.❏ c. the FDIC provides up to $100,000 insurance for each account at the

financial institution.

Study Objectives


answers to this question as

you read:

1. What is most important

to a financial institution

when they make a loan?

How did you do?:1.b 2.a,c


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While different lending institutions offer different types of products and services, theyalso have some things in common. Lending institutions are• Accountable for their activities. Most lending institutions’ activities are overseen by at

least one outside organization. The regulating and oversight organizations (e.g.,government regulators, boards of directors, and investors) make sure that the lending institution makes loans that will be repaid. They also monitor the lending institution sothat it does not take advantage of borrowers.

• Dependent on borrowers’ loan repayment to stay in business. Lending organizations need to be repaid in order to have money to lend to other community members aswell as to repay their own debts to investors.

Whether you seek credit from a bank, a community loan fund, a community

credit union, or a car dealer, the important thing to remember is that lending

decisions are based on your ability to repay the loan.

LENDING

Board of directorsoversees activities

Investors provide money

REGULATORSINVESTORSBOARD OF DIRECTORS

INSTITUTION

COMMUNITY

The lending institution makes loans to community members

Regulators oversee activities


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Evaluating a Loan Application

When a financial institution evaluates a loan application, it isassessing an applicant’s ability to repay a loan. This process isoften referred to as evaluating the five C’s of credit—character,capacity, capital, collateral, and conditions.

Character

Lenders look at a person’s credit report as well as the person’schecking and savings accounts to assess how well the personhandles financial obligations. An applicant’s credit history is oneof the most important factors in establishing his or her ability to

repay a loan. If a person does not have any established credit, lenders will look at anontraditional credit history. To build a nontraditional credit history:• Keep copies of your paid bills.• Keep copies of the canceled checks used to pay bills.• Ask those people/organizations to whom you pay bills to write a letter stating

how long you have been a customer and paid your bills on time.

If a person has a poor credit history, it is important to take steps to repair it. Inaddition, an applicant can assemble a nontraditional credit history to demonstrateimproved ability to handle financial obligations.

Lenders also consider as part of character the length of time someone has lived at hisor her current residence. Lenders often feel most comfortable lending to people whohave demonstrated stability in their residence.

SELF-ASSESSMENT 21. Lending decisions are based on:

❏ a. the number of loans the lender needs to make each month.❏ b. an applicant’s relationship with the lender.❏ c. an applicant’s ability to repay a loan.

Study Objectives



as you read:

1 What are the five C’s of

credit?

2 What is a nontraditional

credit history?

3 What is a debt-to-income

ratio?

How did you do?:1.c


Capacity

Lenders look at the amount a potential borrower can afford to pay. This aspect of theevaluation will assess your current income and expenses. Lenders will consider allverifiable sources of income, including employment checks, government checks, andalimony. Expenses include all outstanding loans, credit card debt, child support, andany other expenses you pay each month.

A lender assesses an applicant’s capacity by calculating the relationship between theapplicant’s debt and income. The loan officer will divide the applicant’s total debt byhis or her total income to come up with a debt-to-income ratio (total debt/totalincome = debt-to-income ratio). The acceptable debt-to-income ratio depends on thetype of lending institution and the type of loan. It is generally accepted that a person’stotal debt should not exceed 45 percent of the person’s total income each month. Forexample:

Robert earns $1,600 a month. He pays $500 a month for rent. His car payment is$175 a month. He pays his ex-wife $200 a month alimony and the minimumpayment of $35 on each of two credit cards.

Total monthly debt = $500 + $175 + $200 + $35 + $35 = $945Total monthly income = $1,600Debt-to-income ratio = $945/$1,600 = 59%

Robert’s debt-to-income ratio is too high for most lenders to feel comfortablelending to him. A lender will not want to place any additional financial burden onRobert’s monthly income. He will likely need to pay off some of his debt before alender is willing to make him a loan.

Debt-to-Income Ratio Exercise

Sheri earns $1,500 a month. She pays $300 a month for rent. She pays her entirecredit card bill each month (approximately $100 per month) and does not owe anymoney. She pays $50 a month for her car payment and $50 a month to repay astudent loan. Calculate Sheri’s debt-to-income ratio.

1. Calculate Sheri’s debt-to-income ratio.Total monthly debt = _________________________Total monthly income = _______________________Debt-to-income ratio = $_______ / $________ = ___%

2. Based on Sheri’s debt-to-income ratio, do you think a lender will feel comfortable giving Sheri a loan? ______________

See page 33 for the answers.

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Capital

Depending on the type of loan, lenders are interested in how much of your ownmoney you plan to invest in a purchase. In addition, lenders consider all items of valueowned by the loan applicant. They are interested in the applicant’s resources in casethere is a problem repaying the loan. From the lender’s perspective, someone whoowns property or items of value can sell them to repay a loan.

Collateral

Lenders often ask a borrower to commit something of value to guarantee repaymentof a loan. If a borrower is unable to repay a loan, the lender accepts ownership of theitem as repayment. When evaluating a loan application, lenders look at the value ofthe borrower’s collateral. Often borrowers use their home, car, or savings account ascollateral for a loan. A lender never wants to repossess a borrower’s collateral.Repossession is the last resort.

Conditions

Lenders are interested in any conditions that may affect the applicant’s ability to repaythe loan (e.g., change in the economy, loss of a job, emergency medical bills). Theconsistency of an applicant’s employment is quite important in this part of theevaluation. If you have been at a job for less than two years, you may be asked toprovide additional information about your work history.


11

Evaluating a Loan Application Exercise

As a loan officer for the Pay-Us-Back (PUB) Loan Fund, you make recommendations to the loan committee about who should receive a loan. This month the followingapplications are on your desk. Use the five C’s of credit to assess the applicants’credit worthiness.

1. Kavitha is a 25-year-old single mom. She makes $22,000 a year ($1,833 permonth). She has been working at Home Depot for three years. She has $600 inher savings account at Example Bank. She has one credit card and has made hercredit card payments on time. Her monthly expenses are $800.

Kavitha is applying for a $1,200 loan to purchase a computer. She would like touse the money in her savings account as collateral for the loan.

a. Using the five C’s of credit, what observations can you make about Kavitha’s ability to repay a loan?

1. Character:

2. Capacity:

3. Capital:

4. Collateral:

5. Conditions:

b. What questions would you like to ask Kavitha?

c. Given what you know, do you recommend making Kavitha a loan? _________

Character:credit history

Capacity: repaymentsources, debt-to-income ratio

Capital: personalinvestment,alternative repaymentsources

Collateral: personalvaluables toguarantee repayment

Conditions: situationsthat affect repayment


2. Juan is a 32-year-old man. His ex-wife lives in a nearby community with their 10-year-old son. He makes $24,000 a year ($2,000 per month) working at HomeDepot. He has been at his job for one year. Juan’s credit history indicates a fewlate payments on bills, but nothing that is currently outstanding. He has nosavings. He pays $500 for child support each month. His other monthly expensescost around $700 per month.

Juan is applying for a $1,000 loan to purchase mechanic’s tools. He would like tofix friends’ and family members’ cars to earn some extra money.

a. Using the five C’s of credit, what observations can you make about Juan’sability to repay a loan?

1. Character:

2. Capacity:

3. Capital:

4. Collateral:

5. Conditions:

b. What questions would you like to ask Juan?

c. Given what you know, do you recommend making Juan a loan? ___________

See page 33 for suggested answers.

12







SELF-ASSESSMENT 31. The five C’s of credit:

❏ a. evaluate an applicant’s ability to repay a loan by examining their credit history, repayment sources, personal investment, and other issues affectingtheir financial situation.

❏ b. help a lender to understand an applicant’s financial situation, but they do not affect the loan decision.

2. True or False. If you do not have an established credit history, you should present a nontraditional credit history with your loan application.❏ a. True❏ b. False

3. A debt-to-income ratio is (check all that apply):❏ a. an applicant’s total debt divided by their total income.❏ b. a ratio used to evaluate an applicant’s ability to afford repaying a loan.

Preparing for a Loan Application Exercise

Now that you’ve evaluated other people’s loan applications, how can you prepare astrong application for yourself? Under each of the five C’s of credit, list some actionsthat will help you develop a strong loan application.

1. Character:

2. Capacity:

3. Capital:

4. Collateral:

5. Conditions:







13

How did you do?:1.a 2.a 3.a,b


14

Applying for a Loan

Before you are ready to apply for a loan you should order andreview a copy of your credit report. Review Workbook 3:Understanding Credit and Your Credit Report for an explanation ofthis process.

There are a number of steps in the loan application process. Thefollowing diagram outlines the steps to arriving at a loan decision.

Completing a Loan Application

To gain access to credit from a lending institution, you must complete a loan application.Lenders use loan applications to collect information about applicants. They collect informationthat will help them evaluate the applicant’s ability to repay a loan. This information usuallyincludes the following:• loan purpose: What is the applicant going to use the money for?• repayment history: What is the applicant’s credit history?• repayment sources: How is the applicant going to repay the loan? What is the applicant’s

income? Savings? Are there any co-applicants who will be pooling resources?• other debts: Does the applicant owe any other money? Are there any other loans that

the applicant will be paying off at the same time, using the same repayment sources?

Loan applications can take some time to complete. Every loan application asks for similarinformation, as well as authorization to get a copy of your credit report. The following information is necessary to complete a loan application: • name and Social Security number;• address and length of time at the current address;• place of employment and length of time on the job;• monthly income from all verifiable sources;• monthly expenses;• all debts (e.g., loans, credit cards), including the lender’s name and the account number.

If you apply with a joint applicant, similar information will be needed from both people.

Some additional information may also be requested during the loan application process, such as:• pay stubs covering the past 30 days;• copies of your income tax returns for the past two years;• paperwork that shows the cost of what you are buying, if you are borrowing to make a

purchase.

When you complete your application, be honest and forthcoming. Provide complete and

Study Objectives


answers to this question as

you read:

1. What type of information

is needed to complete a

loan application?

Loan Decision

Application reviewedby financial

institution using the five C’s of credit

Applicantsubmits loanapplication

Applicantcompletes loan

application


15

accurate information. A lender will verify all of the information that you provide on your loanapplication. If you have had credit problems or other difficulties, share them with the lenderand explain steps you have taken to correct the situation. If you have credit problems that youhave not addressed, discuss actions you can take to deal with them. It is the lender’s job togather information that proves that you will repay a loan.

The following is an example of a loan application:

ABC BANKABC Bank


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Credit Interview

After you complete a loan application, you will go through aninterview with a loan officer. It is the loan officer’s job to reviewthe loan application with you and be sure that it is complete. Theloan officer will probably ask you some specific questions aboutyour loan request. For example, the officer will want to knowhow you will use the money. It is the loan officer’s responsibilityto establish that the loan will be used for a legal purpose. Becooperative and provide all of the information requested.

Credit Scoring

Many lenders use computer models to evaluate loan applications and give them a creditscore. A credit score is used to predict how likely an individual is to repay a new loanbased on the financial institution’s experience with millions of consumers. There aremany different computer models used to calculate a credit score. In general, however,the computer model assigns points to information in a credit report. For example, makingpayments on time every month is a positive credit score. Regularly charging themaximum amount available on a credit card is negative. The computer adds the positiveand negative points, and the resulting number is a credit score. Each lender decideswhat credit score range it considers to be a good or poor risk.

Creditors use credit scoring because it is a fast, objective way to evaluate a credit report.Credit scoring also protects you. This is because your age, health, race, religion, gender,national origin, marital status, income, and employment are not considered in determiningyour credit score.

SELF-ASSESSMENT 41. To complete a loan application, you will need to provide (check all that apply):

❏ a. the loan purpose.❏ b. your name and Social Security number.❏ c. copies of your income tax returns for the last two years.

Study Objectives



as you read:

1. What is the purpose of

the credit interview?

2. What is credit scoring?

3. What are common

reasons for credit denials?

4. What are some ways to

work toward getting a

loan?

How did you do?:1.a,b,c


17

If a lender has turned you down for a loan because of a poor credit score, you should:• Request a written explanation from the lender. Law requires the lender to explain

the reason for the denial.• Make a plan to address the issues.

Also, remember that the lender, not a credit score, makes the final decision to approve a loanapplication. A credit score is simply a tool used by the lender. The lender may take intoconsideration any special reasons for your past credit problems. In addition, the lender will lookat more than just your credit score—such as your equity investment in a home, job history,income, savings, and the type of loan you are requesting—before making a decision.

Credit Denials

Sometimes credit applications are not approved. Some common reasons that loanapplications are denied are:• Poor credit history: Lenders review an applicant’s credit history to evaluate his or her

record of paying bills on time. A credit history is seen as a good indicator of whether someone will repay a loan. Take the time to review your credit report and correct any mistakes.

• Too many open credit cards: Credit cards may be viewed as opportunities for the applicant to acquire additional debt. If the account stays open, the lender considers thecredit available to the applicant. Discuss with a lender whether closing out old credit cardswill positively affect your credit application.

• Too much debt: Lenders compare the applicant’s debt and income. If a lender feels that an applicant is carrying too much debt relative to income, the lender is not likely tomake a loan and add to the applicant’s debt burden. Pay off some debt.

• Employment history: To a lender, steady employment signifies an income stream to repay a loan. Stay in your job or a job in a similar field for at least two years.

• Loan request is too high: An applicant’s financial situation determines the size of the loan that will be approved. If an applicant requests more than this amount, the application will be denied. Discuss an appropriate loan size with your lender.

• Too many credit report inquiries: There are two types of credit inquiries. Promotional or “uninvited inquiries” are a result of creditorspurchasing your name from a credit bureau because you fit a desiredprofile for their product. When the creditor sends you a promotional offer, a“promotional inquiry” is placed on your credit report. Other inquiries resultwhen you express interest in using credit for a purchase. Lenders look at thenumber of this second type of inquiry on your credit report within a six-monthperiod. Too many inquiries signify that an applicant may be trying to get credit from anumber of places. Lenders worry that people are either denying the applicant credit or the


applicant is amassing credit from a number of sources. Either way, the lender sees theinquiries as increasing the risk associated with lending the applicant money.

Do not authorize anyone to run a credit check on you unless you are going to make

a purchase. Check your credit report for unauthorized inquiries and have them

removed. See Workbook 3: Understanding Credit and Your Credit Report for anexplanation of this process.

If you are denied credit, the lending organization is required to provide you with a

reason for the denial within 30 days. You are also entitled to a free copy of your

credit report. If the denial reason is at all unclear, ask the lender to explain it.

Getting to YES

Lenders are in the business of making loans that will be repaid. Applying for credit canbe a frustrating process. Recognize that credit denials and requests for additionalinformation may not be acts of bias or discrimination. Try to understand how the creditdecision is being made and what you can do to satisfy the lender’s criteria. Mostlenders will be very willing to work with you and discuss ways that you can strengthenyour loan application. For example:

Karen applied for an $11,000 car loan. Her credit application wasdenied. When she spoke with her lender, he explained that she didnot make enough money to support the debt. Karen and her lenderthen discussed how much money she could afford to borrow.Ultimately, the lender made Karen a $5,000 car loan. Karen wasable to buy a used model of the car she wanted.

Eric applied for a $5,000 home equity loan. His credit application was denied. When hediscussed the application with his lender, he was told that his credit report showed anumber of late payments and too many open creditcards. Eric explained that his son had been hurt in acar accident and the insurance money did not comeon time to pay the hospital. Everything had beendealt with and there were no other late paymentson his report. At the lender’s suggestion, Eric closedthree of his credit card accounts that he did not use.Eric was able to borrow the $5,000 he requested.

If you are having trouble getting a loan, you might want to discuss with a lender howthe following actions might strengthen your loan application:

• Use collateral to secure your loan. Collateral is something of value that the lender can take and sell if you are unable to repay the loan. Be sure you are comfortable with your ability to repay the loan or you may lose your collateral if youcannot make your loan payments.

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SELF-ASSESSMENT 51. True or False. Credit scoring is based on a lender’s experience with borrowers

repaying their loans.❏ a. True❏ b. False

2. True or False. It will be difficult to get a loan if you do not pay your bills on time.❏ a. True❏ b. False

3. True or False. Lenders are in the business of denying loan applications.❏ a. True❏ b. False

• Put a substantial down payment on your purchase. Your personal investment is important to a lender. A significant down payment can improve your chances ofreceiving a loan. For instance, if you want to make a $6,000 purchase and are able tomake a $3,000 down payment, it may improve your chances of getting the loan.

• Request a friend or a family member with good credit to co-sign or be a

co-applicant on your loan. Make sure you can repay the loan before you consider asking someone to co-sign and put his or her own credit history at risk.

• Establish a nontraditional credit history. To build a nontraditional credit history:• Keep copies of your paid bills.• Keep copies of the canceled checks used to pay bills.• Ask those people/organizations to whom you pay

bills to write a letter stating how long you have been a customer and paid your bills on time.

• Clean up your credit history. If you have a poor credit history, no one can make it go away. Yet, there are steps you can take to rebuild your credit history:• Pay your bills on time.• Stay at your job and at the same residence for an extended period

of time.• Pay down existing debts.• Open a checking or savings account.• Open a secured card or take out a secured loan

from a local lender and repay it. This will begin to establish a positive repayment history.

• Be patient. Reestablishing your credit takes time.

How did you do?:1.a 2.a 3.b


Loan Rates, Terms, and Fees

When you borrow money, the lender charges you for using thefunds (interest). Usually, the cost of borrowing the money is paid forin small amounts over the life of the loan. Every monthly paymentincludes repayment of some of the borrowed amount (principal)and some of the cost of borrowing the money (interest).

Monthly payment = Principal payment + Interest

When you start to repay a loan, your monthly payments aremostly the interest and a small amount of the principal, becauseinterest is repaid first. Throughout the life of a loan, a greater

percentage of your monthly payments become principal and

less is interest.

20

Study Objectives



as you read:

1. How does the monthly

loan payment change

over the life of the loan?

2. How do the interest rate,

term, down payment,

and fees affect the cost

of a loan?

3. What is a payment factor

table?

Interest

Principal

Life of Loan


21

The higher the interest rate, the greater the cost of the credit.

Interest rate 8% 14%

Loan amount $3,000 $3,000Number of monthly payments 48 48Monthly payment $73.24 $81.98Total amount of payment $3,515.46 $3,935.01Cost of credit $515.46 $935.01

The longer the term of the loan, the lower the monthly payment but the greater

the cost of the credit.

Number of monthly payments 36 60

Loan amount $3,000 $3,000Interest rate 12% 12%Monthly payment $99.64 $66.73Total amount of payments $3,587.15 $4,004.00Cost of credit $587.15 $1,004.00

The higher the down payment, the lower the loan amount and the cost of the credit.

Down payment 0% = $0 15% = $450

Purchase price $3,000 $3,000Loan amount $3,000 $2,550Interest rate 12% 12%Number of monthly payments 48 48Monthly payment $79.00 $67.15Total amount of payments $3,792.07 $3,223.26Cost of credit $792.07 $673.26

The higher the loan fees, the higher the cost of the credit.

Loan fees $0 = 0% $100 = 3.3%

Loan amount $3,000 $3,000Net loan proceeds $3,000 $2,900

($3,000 – $100)Interest rate 12% 12%Number of monthly payments 48 48Monthly payment $79 $79Total amount of payments $3,792.07 $3,792.07Cost of credit $792.07 $892.07

Interest

Cost

of

Cred

it

Term

Cost

of

Cred

it

Down Payment

Cost

of

Cred

it

Fees

Cost

of

Cred

it

There are several factors that affect the cost of credit and the monthly payment on aloan. These variables are interest rate, terms, down payment, and fees. Review thefollowing examples to see how the cost of credit can change.


22

To use the payment factor table:1. Identify the payment factor by locating the interest rate and length of time you will

have the loan (in years).2. Calculate the monthly payment by multiplying the loan amount by the payment factor.

Monthly payment = Loan amount x Payment factor

3. Calculate the total cost of the loan by multiplying the monthly payment by the number of months of the loan.Total cost of loan = Monthly payment x Number of months

4. Calculate the cost of the credit by subtracting the loan amount from the total cost of the loan.Cost of credit = Total cost of loan – Loan amount

ExampleIf you borrow $1,500 at a 9 percent interest rate and agree to repay the loan over five years, the costs are as follows:

Loan amount $1,500 Interest rate 9%Time 5 years or 60 monthsPayment factor .02076Monthly loan payment $1,500 x .02076 = $31.14Total cost of loan $31.14 x 60 months = $1,868.40Cost of credit $1,868.40 - $1,500 = $368.40

Payment Factor Table

You can calculate monthly payments or the cost of credit for an installment loan (e.g.,car loan, boat loan) by using a computer program or a payment factor table. You canmultiply the amount you want to borrow by an identified payment factor to calculateyour monthly loan payment.

Interest TERM, IN YEARS Rate 1 2 3 4 5 6 7 8 9 10 15 20 25 303.00% 0.08469 0.04298 0.02908 0.02213 0.01797 0.01519 0.01321 0.01173 0.01058 0.00966 0.00691 0.00555 0.00474 0.004224.00% 0.08515 0.04342 0.02952 0.02258 0.01842 0.01565 0.01367 0.01219 0.01104 0.01012 0.00740 0.00606 0.00528 0.004775.00% 0.08561 0.04387 0.02997 0.02303 0.01887 0.01610 0.01413 0.01266 0.01152 0.01061 0.00791 0.00660 0.00585 0.005376.00% 0.08607 0.04432 0.03042 0.02349 0.01933 0.01657 0.01461 0.01314 0.01201 0.01110 0.00844 0.00716 0.00644 0.006007.00% 0.08653 0.04477 0.03088 0.02395 0.01980 0.01705 0.01509 0.01363 0.01251 0.01161 0.00899 0.00775 0.00707 0.006658.00% 0.08699 0.04523 0.03134 0.02441 0.02028 0.01753 0.01559 0.01414 0.01302 0.01213 0.00956 0.00836 0.00772 0.007349.00% 0.08745 0.04568 0.03180 0.02489 0.02076 0.01803 0.01609 0.01465 0.01354 0.01267 0.01014 0.00900 0.00839 0.0080510.00% 0.08792 0.04614 0.03227 0.02536 0.02125 0.01853 0.01660 0.01517 0.01408 0.01322 0.01075 0.00965 0.00909 0.0087811.00% 0.08838 0.04661 0.03274 0.02585 0.02174 0.01903 0.01712 0.01571 0.01463 0.01378 0.01137 0.01032 0.00980 0.0095212.00% 0.08885 0.04707 0.03321 0.02633 0.02224 0.01955 0.01765 0.01625 0.01518 0.01435 0.01200 0.01101 0.01053 0.0102913.00% 0.08932 0.04754 0.03369 0.02683 0.02275 0.02007 0.01819 0.01681 0.01575 0.01493 0.01265 0.01172 0.01128 0.0110614.00% 0.08979 0.04801 0.03418 0.02733 0.02327 0.02061 0.01874 0.01737 0.01633 0.01553 0.01332 0.01244 0.01204 0.0118515.00% 0.09026 0.04849 0.03467 0.02783 0.02379 0.02115 0.01930 0.01795 0.01692 0.01613 0.01400 0.01317 0.01281 0.0126416.00% 0.09073 0.04896 0.03516 0.02834 0.02432 0.02169 0.01986 0.01853 0.01753 0.01675 0.01469 0.01391 0.01359 0.0134517.00% 0.09120 0.04944 0.03565 0.02886 0.02485 0.02225 0.02044 0.01912 0.01814 0.01738 0.01539 0.01467 0.01438 0.0142618.00% 0.09168 0.04992 0.03615 0.02937 0.02539 0.02281 0.02102 0.01972 0.01876 0.01802 0.01610 0.01543 0.01517 0.0150719.00% 0.09216 0.05041 0.03666 0.02990 0.02594 0.02338 0.02161 0.02033 0.01939 0.01867 0.01683 0.01621 0.01598 0.0158920.00% 0.09263 0.05090 0.03716 0.03043 0.02649 0.02395 0.02221 0.02095 0.02003 0.01933 0.01756 0.01699 0.01678 0.0167121.00% 0.09311 0.05139 0.03768 0.03097 0.02705 0.02454 0.02281 0.02158 0.02067 0.01999 0.01831 0.01778 0.01760 0.0175322.00% 0.09359 0.05188 0.03819 0.03151 0.02762 0.02513 0.02343 0.02222 0.02133 0.02067 0.01906 0.01857 0.01841 0.0183623.00% 0.09408 0.05237 0.03871 0.03205 0.02819 0.02572 0.02405 0.02286 0.02200 0.02135 0.01982 0.01937 0.01923 0.0191924.00% 0.09456 0.05287 0.03923 0.03260 0.02877 0.02633 0.02468 0.02351 0.02267 0.02205 0.02058 0.02017 0.02005 0.0200225.00% 0.09504 0.05337 0.03976 0.03316 0.02935 0.02694 0.02531 0.02417 0.02335 0.02275 0.02136 0.02098 0.02088 0.02085


Interest Rates, Loan Terms, and Fees Exercise

Answer the following questions. Use the chart on page 21 and the payment factor tableon page 22 to assist you.

1. Carrie borrows $1,500 from the Bank to remodel her kitchen. She agrees to pay 8 percent interest on a five-year loan. Using the payment factor table, calculate the cost of Carrie’s credit.a. Loan amount $_____________b. Interest rate 8%c. Time 5 years or ______ monthsd. Monthly loan payment

• Identify the payment factor _____________• Multiply the payment factor by the loan amount

$________ x _______ = $_________

e. Total cost of loan $________ per month x _______ months = $ _________f. Cost of credit $________ – $1,500 = $_________

2. Keith wants to buy a chainsaw that costs $150. The store offers him a payment plan of $20 a month for 15 months. If Keith uses the payment plan to purchase the chainsaw,how much will he pay? _________

3. Maria wants to buy a $5,000 car. She has saved $300 toward this purchase. The interest rate for her loan is 8 percent.a. If Maria makes a down payment of $300, how much money will she need to

borrow to purchase the car? __________b. Will Maria’s cost of credit go down if she uses her $300 as a down payment?____

4. Sonya has a credit card with a 26 percent interest rate. If she pays the total amount duewithin 30 days of receiving her bill, she is not charged any interest.

One day, Sonya charges $71.00 on her credit card. The next day, she sends the creditcard company a check for the full amount. What percent interest did Sonya pay for her purchase? _____ percent

5. Toby is borrowing $3,000 to remodel her house. Credit Union A offers her a loan withan 8 percent interest rate over five years (60 months). Credit Union B offers her a loan with a 10 percent interest rate over three years (36 months).

a. Which credit union is offering the loan with the least expensive monthly payment (monthly payment = loan amount x payment factor)?___________

b. How much less? ___________c. Which credit union is offering the loan with lowest total cost

(total cost of loan = monthly payment x number of months)?___________

See page 35 for the answers.23


24

Personally Evaluating the Deal Exercise

Your financial situation affects your approach to borrowing money. Every borrower needsto evaluate all the costs and terms associated with a potential loan. Borrowers must decideon the best loan product based on their own personal financial situation. For example:

Karime wants to borrow $3,000 to buy a car. After paying his bills each month andaccounting for the cost of living, he has exactly $68.50 to put toward a car payment.Lender A offers him a four-year loan at 8 percent with monthly payments of $73.24.Lender B offers him a five-year loan at 12 percent with monthly payments of $65.97.Karime does some basic calculations to evaluate the two offers.

Lender A Lender B

Loan amount $3,000 $3,000Interest rate 8% 12%Time 4 years 5 yearsMonthly payment $73.24 $66.73Total amount of payments $3,515.52 $4,003.80Cost of credit $515.52 $1,003.80

What should Karime do?________________________________________________________

______________________________________________________________________________

______________________________________________________________________________


Evaluate the Total Cost of a Loan

While it is exciting to get approved for a loan and gain access to credit, it is importantto evaluate the costs. It can be deceiving to focus on any one factor that affects the

price of the credit (e.g., interest rate). It is often worthwhile to “shop” for a gooddeal. This involves talking to a number of lenders about the total cost ofborrowing a certain amount of money. Lenders are required by law to disclosethe total cost of a loan. A lender may offer an appealing package from oneperspective, but the total cost of the credit may not be competitive with thatoffered by other lenders. Make sure to talk about all of the costs involved and

calculate the total cost of the credit.

Beware of loans with a large balloon payment at the back end. Balloon loans offerlower interest rates for shorter-term financing, usually five, seven, or 10 years. At theend of this term, they require refinancing or paying off the outstanding balance with alump-sum payment. If the original loan does not guarantee a new loan with reasonablerates, the refinanced loan can cost you even more money because of loan fees andthe uncertainty of rates in the future.


25

Also, pay attention to loan fees. Loan fees increase the cost of credit. A fee is anycharge added to the price of the loan. Loan fees vary with each lending institution andmay include fees for the application, origination, appraisal, title search, or titleinsurance, or fees triggered by late loan payments. In most cases, loan fees shouldnot exceed 5 percent of the loan amount unless you are paying for a lower interestrate.

If you have any questions, make sure you talk to a trusted adviser who has lendingexperience before you agree to the cost and terms of a loan.

SELF-ASSESSMENT 61. Over the life of a loan:

❏ a. a greater percentage of your monthly payments become principal and less is interest.

❏ b. a greater percentage of your monthly payments become interest and lessis principal.

2. The higher the interest rate:❏ a. the lower the cost of credit.❏ b. the higher the cost of credit.

3. The longer the term:❏ a. the lower the cost of credit.❏ b. the higher the cost of credit.

How did you do?:1.a 2.b 3.b


Predatory Lending

While most lenders conduct honest business, some do not.Predatory lending is when a lender directs a borrower awayfrom loans with more affordable interest rates. Instead, theapplicant is offered a loan with a high interest rate, questionablefees, or unnecessary charges. Predatory lenders often target low-and moderate-income persons, people of color, and the elderly.

Predatory lenders have many of the following traits:• They offer loans based solely on the equity in a home and not on the borrower’s

ability to repay the loan.• They charge unusually high interest rates for a loan.• They add excessive points to the loan without lowering the interest rate.• They include excessive fees.• They tack on unnecessary costs such as prepaid, single-premium life insurance.

Avoid predatory lenders:

• Turn away loan offers from anyone who calls you on the telephone or

comes to your door without an invitation. Throw away mail from companies offeringto arrange a loan for you. Advertisements promising easy money should be viewed withcaution. Remember, if an offer sounds too good to be true, it probably is.

• Be wary of high-pressure sales pitches, such as claims that an offer is good

only for a limited time. If the offer is good—and legitimate—today, it should still begood tomorrow. Take time to check it out.

• If you’re thinking about consolidating your debts into a home equity loan,

talk to a local nonprofit housing or consumer credit-counseling agency first. Theseagencies have your best interest in mind. They may be able to help you work out creditarrangements to avoid debt consolidation altogether. If debt consolidation is the mostappropriate choice, they can help you select the best available options. Without theirassistance, you may choose a bad loan and end up losing your home.

• Avoid loans that include extras you don’t need. Loans should not include unnecessary costs. Consult an adviser to discuss any additional costs that are beingadded to the loan.

26

Study Objectives



as you read:

1. What is a predatory

lender?

2. How can you avoid

predatory lenders?


27

• Never sign an agreement that you do not completely understand, and do not

take a lender’s word that an agreement is “standard.” If the agreement seemsunreasonable or uses terms that are unfamiliar to you, ask for a complete copy ofthe loan agreement. Get a second opinion from someone you trust before you signthe loan agreement. Ask your adviser or local nonprofit housing or consumer creditcounselor to review it.

• Speak to people you trust who have borrowed money. Word of mouth can be a way to learn about predatory lenders.

• Fill in all blank spaces. If an answer is not required, write “N/A” (not applicable) in the blank. Do not sign a document until you have completed every space.Someone could fill in the blank later and make you responsible for somethingwithout your knowledge or agreement.

• Investigate current interest rates. Interest rates vary depending on the financial institution, the type of loan, your credit history, and your ability to repay.Call around to a number of financial institutions to discuss the interest rates andloan options that are available. If the interest rate seems excessively high, checkwith a trusted adviser before you agree to it.

As you investigate loan options, be sure not to agree to anything that you do notunderstand. Do not hesitate to call on community resources, such as Consumer CreditCounseling Service (call toll-free at 1-866-499-8771) or nonprofit housing agencies.Many of these community contacts will provide free services and can be valuableresources.

SELF-ASSESSMENT 71. A predatory lender:

❏ a. hangs around a borrower’s home in order to get their business.❏ b. takes advantage of borrowers’ inexperience and directs them away from

loans with affordable interest rates.❏ c. sells predatory loans.

2. You can avoid predatory lenders by (check all that apply):❏ a. never signing an agreement that you do not understand.❏ b. avoiding high-pressure sales situations.❏ c. researching all of your options.

How did you do?:1.b 2.a,b,c


Insurance

When you take out a loan to make a purchase (e.g., car, house) most lenders will require youto insure the item. Insurance is a tool to protect you when something goes wrong. It can bepurchased for almost anything. The basic types of insurance are:

Homeowner’s insurance

Homeowner’s insurance protects your housing investment. To receive a traditional mortgage, youwill likely need the following: • Property damage coverage reimburses you for damage or loss to your house and belongings.

It usually covers natural disasters (e.g., fire) and man-made disasters (e.g., theft, electricalfire). Areas that are prone to certain types of weather may offer policies that excludecommon circumstances in that area. In these cases, you will need to purchase a separatepolicy to cover the possibility of property damage.

• Liability insurance protects you from people who might sue you for injuries or property damage. For example, if a dead tree on your property falls and damages the neighbor’sproperty, you may be liable. This type of insurance would help cover the costs of repairing thedamage to your neighbor’s property.

Renter’s insurance

Renter’s insurance is similar to homeowner’s insurance. It is for those who do not own theirhouse. This type of coverage will reimburse you for damage or loss of your personal propertydue to events such as fire, theft, or water damage.

Automobile insurance

Automobile insurance is very important and in many states mandatory. It is essential to haveenough coverage to fully cover any costs in the event that you cause harm to a person orproperty. If you do not have adequate insurance, an injured party can gain access to your assetssuch as savings or property. Everyone who drives a car should have the following types ofinsurance:• Bodily injury liability covers injuries suffered by others hurt in an accident while you are

driving.• Property damage liability covers damage done by your car to the property of others. • Collision coverage pays for damage done to your car in an accident. You will want enough

coverage to fully replace your car.• Comprehensive coverage pays for damage done to your car in an event other than an

accident, such as theft or fire.• Uninsured or underinsured motorist insurance covers your expenses in the event that you are

in an accident with someone who either does not have automobile insurance or is underinsured to cover the damages.

Health insurance

Health insurance helps pay your medical bills. There are two basic types of coverage. A basicplan covers regular medical expenses such as doctor visits and prescriptions. There is usually aset dollar limit on this coverage. Major medical coverage covers more expensive procedures.

28


29

Credit life insurance

This insurance repays the lender for the balance of a loan in the event of the borrower’sdeath or disability. This type of insurance can be purchased from the lender when you takeout a loan. Be aware that it will add to the total cost of your loan and make payments higher.

A lender should not ask for a premium to be paid up front. This practice is frequentlyseen among predatory lenders. Investigate your options before you choose a policy.

Disability insurance

Disability insurance protects you against a loss of income if you are unable to work for a longtime because of injury or illness. Before you purchase this type of insurance, be sure toinvestigate the coverage you already have, such as employer-provided sick leave, worker’scompensation, Medicaid, and Social Security.

Life insurance

A life insurance policy provides money to your beneficiary (typically a surviving spouse ordependents) in the event of your death. If you have dependents or major financial obligations,you might consider purchasing life insurance. Be sure to clearly identify the beneficiary ofyour plan. The insurance company will only compensate people you identify. You can changeyour beneficiaries at any time. The following types are available:• Term insurance offers you coverage for a specific period of time. It is often the least

expensive option, but the cost increases as you age.• Cash-value insurance provides your dependents with a cash payoff at your death, as

well as providing you with a tax-deferred savings program. There are a variety ofprograms, such as whole life, universal life, and variable life. While the monthly premiumis higher than on term insurance, it will never go up for your entire lifetime. Part of themoney you pay goes toward insuring your life. The other part is invested by the insurancecompany and becomes an additional savings account for your use.

Before you purchase any type of insurance, be sure to research the options that are available.Call different insurance companies and investigate different types of coverage. If you haveany questions or would like more information about a particular type of insurance, you cancall the National Insurance Consumer Helpline at 1-800-942-4242.


30

SELF-ASSESSMENT 81. What type of insurance protects you against the loss of income if you are unable

to work a long time because of injury or illness?❏ a. health insurance❏ b. credit life insurance❏ c. disability insurance

2. What type of automobile insurance coverage pays for damage done by your car to the property of others?❏ a. bodily injury liability coverage❏ b. property damage liability coverage❏ c. collision coverage

3. What type of insurance reimburses you for damage or loss to your house and belongings?❏ a. life insurance❏ b. disability insurance❏ c. homeowner’s insurance

How did you do?1.c 2.b 3.c


31

Summary Points

• Financial institutions are businesses that provide services such as checking accounts, savings accounts, and loans. Banks, savings and loans, credit unions, finance companies, and loan funds are all types of financial institutions.

• The Federal Deposit Insurance Corporation (FDIC) or National Credit Union Share Insurance Fund (NCUSIF) insure checking and savings accounts at government-regulated financial institutions for up to $100,000 per account.

• All financial institutions make loan decisions based on an applicant’s ability to repay a loan.

• The five C’s of credit include character (credit history), capacity (repayment sources, debt-to-income ratio), capital (personal investment, alternate repayment sources), collateral (personal valuables to guarantee repayment), and conditions (situations that affect repayment).

• Be honest and forthcoming on your loan application. Take the time to collect all of the necessary information and discuss any questions you have with a representative at the financial institution or Consumer Credit Counseling Service (1-866-499-8771).

• Throughout the life of a loan, a greater percentage of your monthly payments become principal and less is interest.

• The higher the interest rate, the greater the cost of the credit.

• The longer the term of the loan, the lower the monthly payment but the greater the cost of the credit.

• The higher the down payment, the lower the loan amount and the cost of the credit.

• The higher the loan fees, the higher the cost of the credit.

• Predatory lenders take advantage of inexperienced borrowers by directing them away from affordable loans.

• Always research your loan options and discuss any questions with industry experts such as Consumer Credit Counseling Service (call toll-free at 1-866-499-8771).

• Many lenders will require you to have insurance before they will make you a loan. Research your insurance options and discuss any questions with industry experts such as the National Insurance Consumer Helpline at 1-800-942-4242.


32

Kn

ow

led

ge

Re

vie

w To review the concepts covered in this session, complete the Journal or the Self-Assessment exercise.

Journal

Take a few moments to write down the most important or useful ideas you learned in this workbook.What concepts do you want to remember?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Self-Assessment

Answer the following questions. Use the information in this workbook to help you.

1. What are some differences between a credit union and a finance company?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

_____________________________________________________________________________________________

2. All financial institutions make lending decisions based on an applicant’s ability to ________________.

3. How can a person create a nontraditional credit history?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

_____________________________________________________________________________________________

4. Why do lenders care about an applicant’s debt-to-income ratio?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

_____________________________________________________________________________________________


_____________________________________________________________________________________________

_____________________________________________________________________________________________

_____________________________________________________________________________________________

6. The ____________ the interest rate the lower the cost of credit.

7. The longer the term, the _________ the monthly payment but the _________ the cost of credit.

8. The higher the loan fees, the _____________ the cost of credit.

9. List three ways to avoid a predatory lender:

_____________________________________________________________________________________________

_____________________________________________________________________________________________

_____________________________________________________________________________________________



33

Debt-to-Income Ratio Exercise

1. Calculate Sheri’s debt-to-income ratio.

Total monthly debt = $300 + $100 + $50 + $50 = $500Total monthly income = $1,500Debt-to-income ratio = $500/$1,500 = 33%

2. Based on Sheri’s debt-to-income ratio, do you think a lender will feel comfortable making Sheri a loan?

Yes

Evaluating a Loan Application Exercise

1. Kavitha is a 25-year-old single mom. She makes $22,000 a year ($1,833 per month). She has been working at Home Depot for three years. She has $600 in her savings account at Example Bank. She has one credit card and has made her credit card payments on time. Her monthly expenses are $800.

Kavitha is applying for a $1,200 loan to purchase a computer. She would like to use the money in her savings account as collateral for the loan.

a. Using the five C’s of credit, what observations can you make about Kavitha’s ability to repay a loan?

1. Character:

• Good credit history• Good work history (three years at job)

2. Capacity:

• Total monthly debt = $800• Total monthly income = $1,833• Debt-to-income ratio = $800/ $1,833 = 44%

3. Capital:

• $600 in bank account

4. Collateral:

• $600 in bank account

5. Conditions:

• Good work history indicates a consistent source of income

b. What questions would you like to ask Kavitha? Do you have any additional sources of income that might help you repay this loan?

c. Given what you know, do you recommend making Kavitha a loan?Yes. She has demonstrated strong financial management skills by paying her bills on time and establishing a savings account.

2. Juan is a 32-year-old man. His ex-wife lives in a nearby community with their 10-year-old son. He makes $24,000 a year ($2,000 per month) working at Home Depot. He has been at his job for oneyear. Juan has a credit history indicating a few late payments on bills, but nothing that is currentlyoutstanding. He has no savings. He pays $500 for child support each month. His other monthlyexpenses cost around $700 per month.

An

sw

er

Se

ct

ion


34

Juan is applying for a $1,000 loan to purchase mechanic’s tools. He would like to fix friends’ andfamily members’ cars to earn some extra money.

a. Using the five C’s of credit, what observations can you make Juan’s ability to repay a loan?

1. Character:

• Moderate credit history indicated by some late payments

2. Capacity:

• Total monthly debt = $700 + $500 = $1,200• Total monthly income = $2,000• Debt-to-income ratio = $1,200/$2,000 = 60%

3. Capital:

• No savings

4. Collateral:

• No valuables identified for collateral

5. Conditions:

• Additional work history will help evaluate Juan’s ability to remain employed

b. What questions would you like to ask Juan? • Is there any way for you to decrease your expenses?• Do you have any collateral to secure the repayment of the loan?• How much money will you earn each month fixing people’s cars?

c. Given what you know, do you recommend making Juan a loan?• No. Juan is probably not ready for a loan. His debt-to-income ratio is too high and his

repayment history is not strong enough.

Preparing for a Loan Application Exercise

1. Character:

• Establish a good credit history by paying bills on time• Establish a good credit history by opening a secured credit card account or a store credit card and

by paying bills on time

2. Capacity:

• Maintain a stable residence• Save money each month

3. Capital:

• Open a checking and/or savings account• Save money each month

4. Collateral:

• Establish the value of your possessions

5. Conditions:

• Maintain stable employment• If you are applying for a business loan, educate your lender about potential markets for your

product


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Interest Rates, Loan Terms, and Fees Exercise

1. Carrie borrows $1,500 from the Bank to remodel her kitchen. She agrees to pay 8 percent interest on a five-year loan. Using the payment factor table, calculate the cost of Carrie’s credit.

a. Loan amount $1,500b. Interest rate 8%c. Time 5 years or 60 monthsd. Monthly loan payment

• Identify the payment factor .02028• Multiply the payment factor by the loan amount

$1,500 x .02028 = $30.42

e. Total cost of loan $30.42 per month x 60 months = $1,825.20f. Cost of credit $1,825.20 – $1,500 = $325.20

2. Keith wants to buy a chainsaw that costs $150. The store offers him a payment plan of $20 a month for 15 months. If Keith uses the payment plan to purchase the chainsaw, how much will he pay? $300

3. Maria wants to buy a $5,000 car. She has saved $300 toward this purchase. The interest rate for her loan is 8 percent.a. If Maria makes a down payment of $300, how much money will she need to borrow to purchase

the car? $4,700b. Will Maria’s cost of credit go down if she uses her $300 as a down payment? Yes

4. Sonya has a credit card with a 26 percent interest rate. If she pays the total amount due within 30 days of receiving her bill, she is not charged any interest.

One day, Sonya charges $71.00 on her credit card. The next day, she sends the credit card company acheck for the full amount. What percent interest did Sonya pay for her purchase? 0 percent

5. Toby is borrowing $3,000 to remodel her house. Credit Union A offers her a loan with an 8 percent interest rate over five years (60 months). Credit Union B offers her a loan with a 10 percent interest rate over three years (36 months).

a. Which credit union is offering the loan with the least expensive monthly payment (monthly payment = loan amount x payment factor)? Credit Union ACredit Union A monthly payment = $3,000 x .02028 = $60.84Credit Union B monthly payment = $3,000 x .03227 = $96.81

b. How much less? $35.97$96.81 – $60.84 = $35.97

c. Which credit union is offering the loan with lowest total cost (total cost of loan = monthly payment x number of months)? Credit Union BCredit Union A total cost of loan = $60.84 x 60 months = $3,650.40Credit Union B total cost of loan = $96.81 x 36 months = $3,485.16


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Personally Evaluating the Deal Exercise

Karime has a number of options:1. The package that Lender B has offered works within his current budget, so he can accept it.

2. He can see that Lender A’s offer will cost him less money over the life of the loan. Karime can go back to his budget and consider ways to decrease his monthly expenses by $7.27 so that he can afford the larger monthly car payment.

3. Karime can go back and negotiate with either of the lenders to see if they are able to offer him a more appealing loan package.

There is no right or wrong answer. As a borrower, you need to evaluate what makes sense for yourpersonal situation.

Knowledge Review Answers

Self-Assessment

1. What are some differences between a credit union and a finance company?• Credit unions are nonprofit financial institutions while finance companies are for-profit.• Credit unions offer depository and credit products while finance companies only offer credit

products.• Deposits at credit unions are NCUSIF-insured.

2. All financial institutions make lending decisions based on an applicant’s ability to repay the loan.

3. How can a person create a nontraditional credit history?

To build a nontraditional credit history:• Keep copies of your paid bills.• Keep copies of the canceled checks used to pay bills.• Ask those people/organizations to whom you pay bills to write a letter stating how long you

have been a customer and paid your bills on time.

4. Why do lenders care about an applicant’s debt-to-income ratio?

The debt-to-income ratio indicates whether a borrower can afford a monthly loan payment. Thefinancial institution evaluates the applicant’s income relative to expenses. If a high percentage of anapplicant’s income is already being used for existing financial obligations (more than 45 percent),then the financial institution will not want to increase the applicant’s monthly expenses.


Credit scoring is a process used by financial institutions to evaluate loan applications. It uses thefinancial institution’s historical experience with borrowers to predict whether the borrower will beable to repay the loan.

6. The lower the interest rate the lower the cost of credit.

7. The longer the term, the lower the monthly payment but the higher the cost of credit.

8. The higher the loan fees, the higher the cost of credit.


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9. List three ways to avoid a predatory lender:

To avoid predatory lenders:• Turn away loan offers from anyone who calls you on the telephone or comes to your door

without an invitation.• Be wary of high-pressure sales pitches, such as claims that an offer is good only for a limited

time.• If you are thinking about consolidating your debts into a home-equity loan, talk to a local

nonprofit housing organization or call Consumer Credit Counseling Service (1-866-499-8771).• Avoid loans that include extras that you do not need.• Never sign an agreement that you do not completely understand, and don’t take a lender’s

word that an agreement is “standard.”• Speak to people you trust who have borrowed money.• Fill in all the blank spaces on applications and documents that you complete.• Investigate current interest rates at a number of financial institutions.


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Account statement – This is a record of your account activity over a specific period of time.

Annual percentage rate (APR) – The annual interest rate that reflects all of the costs of financing. This rateprobably will be higher than the original interest rate quote, because it includes all other costs of gettingcredit, such as loan fees.

Assets – Financial assets are cash or something that can be converted into cash, such as a savings account,stocks, or real estate.

Automated teller machine (ATM) – ATMs are machines that provide many of the same services as afinancial institution. Many financial institutions own ATMs to provide convenient service to their customers.There are various fees attached to using an ATM for financial transactions.

Available balance – This is the amount of money immediately available in your account. This amount doesnot reflect any withdrawals or deposits that have not yet cleared your account.

Balloon payment – This is the payment that is due at the end of a balloon loan. A balloon loan offers alow interest rate for short-term financing. At the end of the term, the loan requires refinancing or payingoff the outstanding balance with a lump-sum payment.

Bounced check – A check that is returned to you because there is not enough money in your account tocover it.

Canceled check – Once a check has been processed and subtracted from the account on which it waswritten, it is called a canceled check. Canceled checks are often used as “proofs of payment,” in place ofreceipts.

Cashier’s check – This type of check is as good as cash. To issue a cashier’s check, the financial institutionwill deduct funds from your account and write the check from its own account. There is usually a fee for acashier’s check.

Check register – A tool for keeping track of the daily balance in your checking account.

Clears – A check you write clears when the amount of the check has been withdrawn from yourchecking account by the financial institution.

Co-borrowers – Two or more persons who legally agree to take out and be responsible for paying off a loantogether.

Collateral – Something of value that the borrower commits to guarantee repayment of a loan.

Commitment letter – A formal offer by a lender stating the terms under which a financial institution agreesto lend money. Sometimes it is called a “loan commitment.”

Contingency – A condition that must be met before a contract is “legally binding,” that is, before you mustlegally complete what was agreed to in the contract.

Credit – Credit is when you borrow funds with the intent to repay them.

Credit bureau – An organization that keeps records of people’s repayment histories (i.e., credit reports).

Credit history – A list of your debts and regular monthly expenses, including how much you owe and howtimely you make your payments.

Credit inquiry – When you apply for credit, the lender will request a copy of your credit report. Eachtime your credit report is requested from the credit bureau it is documented on your report as an“inquiry.”

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Credit rating – A rating that indicates how good a credit risk you are. Credit ratings are based on yourpersonal credit history.

Credit report – A report that reflects a person’s credit history. The lender orders this report from a creditbureau when you apply for a loan.

Credit score – A process used by lenders to evaluate a loan application. A credit scoring system is basedon the lending organization’s historical experience with borrowers.

Customer agreement – A document provided by financial institutions that describes the costs and featuresof their accounts.

Debit – A withdrawal from an account. If you write a $25 check, your account will have a debit of $25when the check clears.

Debit card – A card that can be used at an ATM to conduct financial transactions or at a point of saleterminal (POS) to buy something.

Debt-to-income ratio – A ratio that compares a loan applicant’s total monthly debt to their total income(total monthly debt/ total monthly income = debt-to-income ratio). Lenders use a debt-to-income ratioto help them determine an applicant’s capacity to repay a loan. It is generally accepted that a person’stotal debt should not exceed 45 percent of the person’s total income each month.

Debts – Money you owe.

Deposit – To put money into your account.

Depository services – Checking and savings account services offered by some financial institutions.

Default – Failure to pay back money. If you do not make agreed-upon payments, you default on your loan.

Direct deposit – Funds deposited directly into your account. With your agreement, payroll earnings, SocialSecurity benefits, retirement earnings, and other checks you receive on a regular basis may be direct-deposited into your account.

Down payment – The part of a purchase price that you pay when you buy an item such as a car or ahouse. The lender usually seeks a down payment to show that you are willing to invest in a purchase.

Economy – The way a society organizes to meet the physical needs of its people.

Electronic funds transfer (EFT) – Money transactions to or from checking and savings accounts thatdo not require paper (checks or cash) but use computer technology. Examples include direct deposit,ATM, and debit card transactions.

Emergency reserve fund – Money you put into an account and save for an emergency.

Endorse – Endorsing a check is when you sign the back of a check that is made out to you in order torelease the funds.

Expenses – The amount of money you spend on a regular basis.

Federal Deposit Insurance Corporation (FDIC) – The organization that insures accounts at federalgovernment-regulated financial institutions for up to $100,000 per account.

Fixed expenses – Monthly household costs that do not change.

Flexible expenses – Monthly household costs that you can control, such as groceries.


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Forgery – When a person purposefully tries to withdraw money from your account by pretending to beyou.

Gross annual income – Total yearly income from all sources before taxes are deducted.

Hold – The number of days a financial institution will hold a check before crediting your account.

Installment credit – This type of credit allows you to borrow a specific amount of money at one time for adefined purpose. You make a set payment each month.

Interest – A fee paid for the use of money. A financial institution will pay you interest for keeping yourmoney at their location. You will pay interest to a financial institution for the use of borrowed funds.

Joint applicant – When two or more people apply together for a loan.

Loan processing – The steps a lender takes to decide if a buyer can qualify for a loan.

Long-term goals – Savings goals you can accomplish by consistently setting aside money for severalyears.

Luxury expenses – Monthly costs that you choose, such as new clothes and going out for meals.

Market economy – An economic system where goods and services must be purchased from others.

Market value – The expected sale price of something.

Minimum balance – Necessary amount of money on deposit to qualify for special services.

Minimum payment – Smallest possible monthly payment.

Monthly statement – Account summary mailed monthly to a customer.

National Credit Union Share Insurance Fund (NCUSIF) – Insures accounts at federal government-regulated credit unions for up to $100,000 per account.

Net income – Your total income after taxes are taken out.

Noninstallment or service credit – Some businesses and utility companies offer this type of credit. Itallows you to pay for a used service at a later date.

Nonsufficient funds (NSF) – A term meaning that the amount of money in your account is less than theamount you would like to withdraw. Also referred to as insufficient funds.

Nontraditional credit history – A credit history you can prepare if you do not have credit cards or havenever had a loan. It can include receipts and canceled checks from your monthly payments for rent, utilities,and other bills.

Overdraft protection – A line of credit to cover nonsufficient funds.

Overdrawn – When more is withdrawn from an account than the existing balance.

Payment factor table – A table that you can use to calculate monthly payments and the cost of credit forinstallment loans.

Personal identification number (PIN) – Your password to your account at a financial institution. Youcan use your PIN to gain access to your account at an ATM or point of sale terminal (POS).


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Point of sale terminal (POS) – A terminal consumers use to make purchases with a debit card atbusiness locations.

Predatory lender – A lender that directs a borrower away from loans with more affordable interest rates.Instead, the applicant is offered a loan with a high interest rate, questionable fees, or unnecessary charges.

Principal – The amount you can actually borrow.

Promotional inquiry – When a company requests a copy of your credit report to “pre-approve” you fora credit card or special offer, it is recorded on your report. This type of inquiry is listed separately fromcredit inquiries that you request. Potential creditors will only see the credit inquiries that you initiate.

Purchase and sale agreement – A written contract that the buyer and seller sign. It includes all of theterms and conditions of the sale.

Qualify – To determine how much money you are able to borrow.

Reconciling – To balance your checkbook by comparing your check register with your account statement.

Repossess – When a financial institution takes ownership of an item that was purchased using creditbecause the borrower is not able to repay the loan.

Revolving credit – This type of credit allows you to borrow money at any time up to a set limit. As you paythe borrowed money back, it becomes available again to borrow (e.g., credit cards).

Savings goals – Statements about things you wish you could afford.

Secured credit – This type of credit requires that you provide something of value to guarantee repaymentof a loan.

Secured credit card – This type of credit card requires that you deposit a certain amount of cash in asavings account to guarantee your credit card.

Service charge – Financial institutions sometimes charge fees for specific services. These fees will varydepending on the type of account you have. Ask about service charges and fees before you select afinancial institution or a type of account.

Short-term goals – Savings goals you can accomplish in a few weeks or months by consistently settingaside money.

Signature card – A card that you sign when you open an account. This card is kept on file at thefinancial institution and used to verify your signature when you cash checks. This helps to preventunauthorized people from gaining access to your account.

Spending plan – A strategy for saving and spending money. It can be used as a guide to help you track theflow of money through your household and how that money needs to be divided to meet expenses andsavings goals.

Stop payment – An order by a customer not to release issued funds (i.e., not to cash a check).

Terms – The conditions of a loan, including the type, size of down payment, amount you can borrow,interest rate, and length of time to repay.

Tracking – To become aware of the flow of money through your household.

Unsecured credit – This type of credit does not require you to provide something of value to guaranteerepayment of a loan.


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Notes


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Notes



4000 Wisconsin Avenue, NWNorth Tower, Suite OneWashington, DC 20016

www.fanniemaefoundation.org

2455 Paces Ferry Road, NWAtlanta, GA 30339-4024

www.homedepot.com

100 Edgewood Avenue, NESuite 1800

Atlanta, GA 30303

www.cccsatl.org


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